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Edited version of your written advice

Authorisation Number: 1051279875596

Date of advice: 08 September 2017

Ruling

Subject: GST and out-of-court settlement

Question

Is the out-of-court settlement sum Entity A received pursuant to the Settlement Deed subject to goods and services tax (GST)?

Answer

Yes.

Relevant facts and circumstances

According to the Settlement Deed, the facts are:

    ● Entity A was the owner of a block of land (Block A).

    ● Entity A is registered for GST and is in the business of property development.

    ● Entity A entered into an agreement with another party (Entity B) regarding the sale of the Block A and the subdivision of another block of land (Block B) owned by Entity B.

    ● Entity A transferred Block A to Entity B and also incurred costs in subdividing Block B.

    ● A dispute arose regarding the agreement and Entity A commenced a legal proceeding seeking:

      (a) reimbursement of amounts it had expended in subdividing Block B; and

      (b) recovery of the price of the Block A .

    ● Entity A reached an out-of-court settlement with Entity B to settle and finalise all matters relating to the proceedings and a settlement sum was paid by Entity B to Entity A.

    ● There is no dissection or itemisation of the settlement sum

Relevant legislative provisions

A New Tax System (Goods and Services Tax) Act 1999 section 9-5

A New Tax System (Goods and Services Tax) Act 1999 section 9-10

A New Tax System (Goods and Services Tax) Act 1999 section 9-15

Reasons for decision

Taxable supply

GST is payable on taxable supplies. Section 9-5 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides that you make a taxable supply if:

    ● you make the supply for consideration; and

    ● the supply is made in the course or furtherance of an enterprise that you carry on; and

    ● the supply is connected with the indirect tax zone; and

    ● you are registered or required to be registered.

However, the supply is not a taxable supply to the extent that it is GST-free or input taxed.

The term ‘supply’ is defined in subsection 9-10(1) of the GST Act as ‘any form of supply whatsoever’ and includes an entry into, or release from, an obligation to do anything; or to refrain from an act; or to tolerate an act or situation (Paragraph 9-10(2)(g) of the GST Act).

Possible supplies in out-of-court settlements

Goods and Services Tax Ruling Goods and services tax: GST consequences of court orders and out-of-court settlements (GSTR 2001/4) deals with the GST consequences of court orders and out-of-court settlements and discusses the meaning of supply. According to GSTR 2001/4, a supply related to an out-of-court settlement may have occurred prior to the settlement or it may be created by the terms of the settlement itself. There may be more than one supply that is related to a settlement and in addition, the subject of the dispute may not be a supply at all.

In particular, GSTR 2001/4 explains that supplies related to out-of-court settlements fall into three types. These are:

    ● earlier supply

    ● current supply

    ● discontinuance supply.

Earlier supplies are supplies made prior to the out-of-court settlement and where both the supplier and the recipient have some dispute regarding the supplies.

Current supplies are supplies created by the terms of the out-of-court settlement.

A discontinuance supply is, according to paragraph 54 of GSTR 2001/4:

    (i) surrendering a right to pursue further legal action [paragraph 9-10(2)(e) of the GST;

    (ii) entering into an obligation to refrain from further legal action [paragraph 9-10(2)(g)]; or

    (iii) releasing another party from further obligations in relation to the dispute [paragraph 9-10(2)(g)].

In finalising a dispute, a settlement will generally ensure there is no further legal action in relation to that dispute. Such a settlement could be the plaintiff releasing a defendant from some (or all) of the existing claims and from further claims and obligations in relation to the dispute. Therefore a discontinuance supply could arise.

The earlier supply

Prior to the settlement, Entity A has made a supply of the Block A to Entity B and this supply is part of the dispute that led to the legal proceedings. Therefore, this earlier supply relates to the out-of-court settlement. The supply would be a taxable supply as section 9-5 is satisfied.

The discontinuance supply

According to paragraph 109 of the GSTR 2001/4, the payment made under a settlement deed may have a nexus with a discontinuance supply only if there is overwhelming evidence that the claim which is the subject of the dispute is so lacking in substance that the payment could only have been made for the discontinuance supply.

Although both parties agreed not to continue proceedings against each other subject to the payment of settlement sum, based on the facts provided, we do not consider that the payment of the settlement sum is made for the discontinuance supply.

The current supply

There is no current supply identified from the terms of the Settlement Deed.

The damages claim

Based on the facts provided, Entity A had a claim to seek reimbursement of amounts it had expended in subdividing Block B. This is considered a damages claim. Paragraphs 73 and 110 of GSTR 2001/4 state:

      73. The most common form of remedy is a claim for damages arising out of the termination or breach of a contract or for some wrong or injury suffered. This damage, loss or injury, being the substance of the dispute, cannot in itself be characterised as a supply made by the aggrieved party. This is because the damage, loss, or injury, in itself does not constitute a supply under section 9-10 of the GST Act.

      110. With a dispute over a damages claim, the subject of the dispute does not constitute a supply. If a payment made under a court order is wholly in respect of such a claim, the payment will not be consideration for a supply.

Therefore the damages claim is not a supply for GST purposes.

Supply for consideration

Section 9-15 of the GST Act provides that a payment will be consideration for a supply if the payment is ‘in connection with’ a supply and ‘in response to’ or ‘for the inducement’ of a supply. There must be a sufficient nexus between a particular supply and a particular payment, which is provided for that supply, for there to be a supply for consideration.

There are two elements to the definition of consideration. The first is the payment by one entity to another and the second is the nexus that must be established between the payment and a supply.

In this case, a settlement sum is paid to Entity A as per the Settlement Deed. Therefore, we need to be satisfied that a sufficient connection is established between the payment and a supply.

As discussed above, there is no current supply or discontinuance supply for which the settlement sum has a sufficient nexus. The settlement sum can only link to the earlier supply and the damage claim.

Where a payment made in an out-of-court settlement has a sufficient nexus with more than one supply, with one or more supplies being taxable and one or more being GST-free or input taxed, the payment will be for each relevant part. This will also be the case where the payment is partly for an item of damages which is not a supply.

In the current case, there is no dissection or itemisation of the settlement sum therefore the extent to which the settlement sum relates to each supply is unknown.

Paragraphs 118 and 119 of GSTR 2001 provide that where no dissection is made, the payment should be apportioned into amounts representing these relevant parts in order to achieve the correct GST consequences.